How to Structure Your Next Fix & Flip

What does it even mean to structure a deal?

Structuring deals refers to how the deal is set up and includes several variables such as financing, partnerships, how you hold title, and the time frame you’re working within.

For example:

I can structure a deal so that I am borrowing money from a hard money lender , have no partners, hold the property in my own name, and have 1 year to pay back the loan.

on the other hand...

I can also structure it so that I am using private financing with 2 other partners, held in the name of an LLC and a 3 month turnaround time.

Both types of structures are going to have significantly different costs, payments, time frame and strategies, and people to deal with. Those are just two quick examples , but there is almost a limitless number of ways you can set it up - How we structure a deal can make a big difference in the profit potential. When we structure a deal, we want to look at several key factors:

To start with, determine what your long and short term goals are. You may just be looking for a short term return for a flip right now, but have a long term plan of flipping several homes a year. This makes a big difference because if you plan to take down several properties to flip throughout the year- then you are going want to have a strong marketing plan in place. If this is a onetime deal until you learn the ropes – a marketing plan might not be as important as finding a good partner who knows the landscape.

Partners
Do you want to work alone or with partners? Personally , I find it much more rewarding to work with partners. With a partnership, you may lose a small degree of control , but can gain valuable education in the form of someone else’s experience. You can also increase your purchasing power with partners who have access to cash or credit. Knowing whether you want a partner or not will have a large impact on the structure of your deal – after all... if you are on you’re own, you get keep all the profits. With a partner, you will share those profits – how much of it you share will depend on how you STRUCTURE the deal. Keep in mind that 50% of something of better than 100% of nothing. Partners can bring much more than money to a deal. Their knowledge, experience, contacts, and skill sets can help you avert disasters and help guide you through a successful transaction. For newer investors, the “peace of mind” may be invaluable.

Financing
Another import aspect to structuring is how you plan to finance the project. Do you have your own money or are you borrowing money? Are you pairing your money with someone else and partnering? Perhaps you and your partner have SOME of the money together and need to borrow the rest. Regardless of where it comes from the money has to come from somewhere and there are many places it can be found. Funding is a MAJOR part of your deal structure because it is going to determine whether or not you will have a monthly payment, how much interest you must pay back, possible pre-payment penalties, when you have to start paying it back – all of these are things can affect the bottom line when comes to your profit.
Possible funding sources include:

Hard Money..............................Private Money
Partners .....................................Sellers
Credit Cards ............................Home Improvement Credit (Home Depot, Lowes)
Banks .......................................Mortgage Brokers

All of these forms of funding come with a cost. Hard money and private money will typically be the most expensive, in the form of higher interest rates and points. Partners may take their payment in the form of a percentage of the deal – or they may charge you interest and can even be a combination of the two. Sellers might be willing to “carry the loan” or in other words, allow you to make payments to them for the house – in most cases, they will price the house higher because of the risk they are taking. Credit cards can be used for cash advances and home improvement cards can be used to help you renovate – the interest on these cards is typically very high and should be paid back as soon as possible to avoid mounting fees. Banks and mortgage brokers will generally have the lowest fees, but have the most stringent qualifications, but if you can qualify, this is can be a great option. If you are putting down less than 20% then you will be required to purchase mortgage insurance. These are all expenses that need to be accounted for also. As you can see – financing plays a big role in how you structure your deal.

Cost Projections
Another important part of structuring your deal is going to involve running the numbers and building models based around your expectations and known variables. What this mean is that you need to run the numbers very carefully and take everything into account that you can. It's important to understand how much you will need before the project, during the project and what the net profit will be after all the expenses are covered. This is where most deals die on the vine and investors hang themselves. Underestimating rehab costs can be the nail in your coffin. When calculating everything, be sure to account for the unknown and build it into the budget. Many investors like to use 10% of rehab cost as a buffer – we call this the fudge factor. Be sure to understand all the costs involved – many newer investors don’t realize this, but there are costs involved even before the deal is struck.

For example:

Let’s say that you have the property under contact – you have not bought it yet, but you have the property tied up and are ready for your inspections . You're going to spend money to have the house inspected and you may find out that it has more problems that you anticipated and choose not to buy it. You’re not going to get your money back from that inspection – that money is long gone.

That is only one inspection - you can have roof inspections, pest inspections, septic tank or well inspections, etc. Maybe you paid for 3 inspections and everything looks good, but your fourth inspection reveals problems that are too insurmountable to get over so you don’t move forward with the deal. Again - all the money spent is gone now.

You also need down payment money, good faith deposit, and possibly even lending fees and points. There are also appraisal, title reports, and title insurance that you may have to pay for – and you haven’t even got the keys yet! Therefore, it is very important to estimate the costs and account for them from the offset.

You also need to be able to identify costs that you will incur during the rehab – Once you buy the property , you are responsible for it until you sell it again – this could mean paying for insurance, water/ garbage, and electricity. You may also have holding costs such as loan payments – and we’re not even talking the rehab cost yet. And that brings up to the next point – construction costs – how much is your estimate on the rehab? Did you do it yourself or did it come from a contractor? Did you get a second opinion or does your contractor have a good track record with his estimates? Be sure to include all these costs in your total amount - don’t forget things like garbage removal, tree removals, etc – things like that can add up quickly.
When you sell the property there are still more pitfalls to watch out for – first and foremost is going to be the agent commissions – when you sell your house – unless you are marketing directly - you will likely pay an agent up to 6% for selling your property. That’s $6,000 off a $100,000 sale - $12,000 off a $200,000 sale. In California, where I invest, it is customary for buyer and seller to split title fees and in many cases the buyers request title insurance paid for by the seller. There are also other closing costs involved – you can ask your title company for “Sellers Net Sheet” to help you break down the closing costs and show you what your net check will be.

As you put your deal together, you’ll want to consider whether you want to use an entity to hold title, or not. Are you going to hold it in your own name or are you forming a partnership to hold in two or more names? Many investors use a Limited Liability Company (LLC) to help give them a layer of protection from litigation. An LLC is simply a corporate entity that you can form by filing the right paperwork and fees with the state. Once you own an LLC, you can buy property in the name of the LLC and as the name implies – it helps to limit your exposure to liability. If someone decides to sue the owner of the house, they look it up and find it owned by an entity - not by YOU or your partners specifically. A popular way the LLC is used involves setting up a new LLC for each property you own – that way if someone tries to sue the LLC – there is only one property in it that would be at risk. If you are flipping and do not plan to hold more than one property at a time – you may not need to worry about setting up a new one for each flip. Be sure to discuss it with an attorney or CPA or both before deciding what the entity works best for your situation.

In summary, structuring a deal requires your due diligence in planning, funding, and follow through. You must plan out whether you are going to buy and hold it or flip it. You need to determine whether you can purchase it on your own or if you will need a partner. Key to understanding what your holding costs are going to be is lining up you financing. Accurate estimates are essential to the profitability of the project. Be sure to consult an attorney or CPA to determine the best way to hold title for the tax purposes and limited liability. Every deal is going to require a different type of structure s don’t try to apply a cookie cutter method to everything – analyze the details of your project and plan accordingly.

If you're interested in Real Estate and Investing please follow my page for regular updates